Module 5: Assessing Enterprise Feasibility

Overview Understand the elements of economic feasibility analysis Evaluate market size and estimate volume Calculate cost of production or service Use break-even analysis to identify minimum required pricing and volumes Compare pricing approaches and select appropriate pricing

Steps in Economic Feasibility Analysis Assess potential demand (volume and pricing) Estimate cost of production Examine break-even volume and pricing Choose a pricing approach

Assess Potential Demand Target consumers who have a need for the product/service Conduct market research – Estimate available customer base and purchase amount – Estimate feasible range of prices (cover production costs) – Assess consumer sensitivity to pricing Market research methods – Survey existing customers – Conduct product/pricing trials – Ask fellow providers – competitors – Use secondary data resources USDA, marketing firms, Extension

Estimating Market Size - Farm Tourism Examples Local Farm Tourism – Local customers traveling for a day or weekend outing, such as in-state or less than 100 miles away – U-pick strawberry operation example Destination Tourists – Visitors on a long vacation to specific destinations National and state parks, heritage sites, etc. – Farm tourism venture example

Local Tourists If selling items directly from farm/ranch – Consider how far you can expect customers to travel The USDA Forest Service's National Survey on Recreation found the average distance traveled to visit a farm in 2000 was 80 miles Western operators find their consumers travel over 75 miles to participate in U-picks, farm festivals, and related farm activities – No other alternatives exist in their metro area

Local Tourists Potential number of customers – Demographics and population size in the area is an important part of estimating demand Demographics from the most recent U.S. Census can be searched online by state and by zip code – Ages, household and family size, income, ethnicity, etc. – All of which can provide information as to the characteristics of potential customers in the surrounding area Potential purchase size – Examining current and historical consumption patterns can be helpful Average annual consumption levels for hundreds of foods in the US can be found on USDA’s Economic Research Service (USDA-ERS) website - products/food-availability-(per-capita)-data-system/.aspxhttp:// products/food-availability-(per-capita)-data-system/.aspx ERS data is for standard, conventional products only

U-Pick Example A strawberry producer is considering turning one acre of the operation into a U-pick Estimates that each acre will yield 10,000 pounds The average annual consumption of strawberries per person is 8 pounds (ERS, 2014) Use the following equation to determine the appropriate market size The producer will need a market size of 64,935 consumers/visits annually to sell all output

U-Pick Example For the U-pick strawberry operation, the producer may be interested in targeting families – Would be helpful to know if nearby communities have enough families to make up a portion of the 65,000 consumers needed to make the U- pick operation feasible Bend/Redmond, OR – 26,073 families, average of 3.5 persons (2010 Census) – 91,255 potential customers

U-Pick Example What percentage might visit the u-pick? – If 40%, then 36,502 customers Almost 30% of the US population visited farms one or more times (2000) – But, agritourism has been growing at a rate of 6% annually If customers purchase 16 pounds/pp for freezing/canning – Only need 32,467 customers/visits annually

Destination Tourists Many rural areas in the West are located between a major urban center and national/state parks, ski resorts, etc. – Vacation destinations for many foreign and out-of-state visitors Estimating the potential size of these markets requires information on – Where visitors are coming from – Where visitors are returning to

Grand Canyon National Park Example Consider Grand Canyon National Park (GCNP) – Attracts around 4.4 million visitors annually GCNP Statistics at m m Seasonal visitation is another important item to consider – Annual visits to the GCNP by season Winter: 11% of total visits Spring: 27% of total visits Summer: 39% of total visits Fall: 23% of total visits – Visitation by month at

Grand Canyon National Park Example Where visitors to Grand Canyon National Park stayed before and after visiting the park

Grand Canyon National Park Example Consider a business located between Page, AZ and GCNP – 3.4% of visitors stayed in Page prior to visiting GCNP – 4.0% of visitors stayed in Page after visiting GCNP The average number of visitors who would pass by this business location can be found with the following equation: The number of GCNP visitors that would pass by the business location each month averages 13,567 – With a low of around 5,970 visitors during the winter months (11% of total) – And a high of 21,164 visitors during the summer months (39% of total)

Grand Canyon National Park Example The Page, AZ business is a farm tourism venture (hay rides, farm stays, etc.) – Assume venture needs to earn an average of $10,000 in sales monthly to be viable – Expects average purchase of $25/person Calculate the percentage of total visitors to GCNP the venture needs to attract

Grand Canyon National Park Example The venture would need to attract 2.9%, on average, of the monthly GCNP visitors – 6.7% of winter visits – 1.9% of summer visits This is a fairly high percentage of total visitors For the business plan to work, the venture may try – Starting the venture on a smaller scale – Attracting more of the heavy summer traffic

Estimate Cost of Production Create enterprise budget, by service/product or product groups Estimate operating costs – Costs that vary with quantity produced Seed, fertilizer, packaging, etc. Estimate fixed costs – Costs incurred regardless of production Land payments, equipment, etc. Calculate break-even cost per unit – Provides lower limit for pricing

Production Costs 5-acres of vegetable production

Investment Summary

Enterprise Budget 5-acres of vegetable production

Break-Even Analysis Break-even analysis answers the questions – How much needs to be sold to break even?” If this quantity fits within potential demand, it may be feasible Calculate break-even quantity/volume across a range of prices – Or – What would the price need to be to break even? If the price that would need to be charged is unrealistic, then the idea is not feasible Calculate break-even prices across a range of possible volumes

Break-Even Example Initial quantity of 20,000 lbs at a price of $.24/lb, or $4,800 in revenue Profit is $1,635 Break-even price is total expenses/number of units (20,000) or $.16/lb Break-even quantity is total expenses/price ($.24/lb) or 13,187 lbs

Estimating Product Price Major pricing approaches – Cost-based – Demand-oriented – Competition-oriented – Not normally used independently

Cost-Based Pricing Cost-plus pricing – Price equals total costs divided by number of units – Shortcomings Not tied to consumer demand No incentive to reduce costs Adjustments for rising costs poor Mark-up pricing – Add a percentage to the cost of product (mark-up) – Very popular for retailers and wholesales Easy, too many products to estimate demand – Shortcomings Not tied to demand Profit biased by pricing

Retail Distribution Example Plan to sell product retail (local tourist shop) Set pricing at retail level and then evaluate demand – Ask wholesales and retailers what margin they require Example – $5.00 cost of production Multiply by 1.25 for wholesale price (Average 20-30%) – $6.25 wholesale Multiply by 1.40 for retail price (Average 30-50%) – $8.75 retail Will consumers pay $8.75? Need to use this price at all outlets

Demand-Oriented Pricing Price at customer value (willingness to pay) Price skimming – Charge high price at first to pick up consumers willing to pay more – Gradually reduce price to pick up consumers who are more price sensitive Penetration pricing – Initial low price to capture market share – Discourages competition – Price is increased later when consumers are hooked – Common in new food products

Determinants of Consumer Price Sensitivity Perceived substitute effect – How many substitutes exist? – If many, then consumers more price sensitive Unique value effect – Increase market share through differentiation – Consumers less price sensitive if “unique” product/service Switching cost effect – Cost of changing from one product to another – People are reluctant to change and seek out new information – Consumers less price sensitive if large switching costs

Determinants of Price Sensitivity Difficult comparison effect – Hard to compare products/services, then consumers less price sensitive Price-quality effect – Often associate a higher price with higher quality Expenditure effect – Consumers more sensitive to price changes on large, expensive products than small, inexpensive ones Price changes on meat compared to salt

Determinants of Price Sensitivity Fairness effect – Impacted by what they consider fair - (sense of value-added) Inventory effect – Seasonality affects price sensitivity Higher demand for steak in summer due to outside grilling End-benefit effect – May be willing to pay more for products that protect the environment, preserve open space, support family farms, etc.

Competition-Oriented Pricing Simple form of pricing Ideal when similar products exist Penetration pricing – Lower than competition pricing – Stimulate demand Parity pricing – Equals competition pricing Premium pricing – Higher than competition pricing – Signal quality

Competitive Analysis How many competitors operate in the market? Are competitors large or small? Near or far? What types and numbers of products do they sell? What pricing methods do they use?

Consider External Factors Distribution – Wholesale and retail margins – Transportation and packaging costs Environmental factors – Taxes, weather events, fad diets, energy policy Legal/regulatory factors – Labeling, certification, permits, safety

Pomegranate Juice Pricing Example Produce and sell juice at specialty/health stores Cost of production is $.80 per 8 oz. juice – $.80 cost of production (multiply by 1.20) – $.96 cost with profit (multiply by 1.25) – $1.20 wholesale price (multiply by 1.40) – $1.68 minimum retail price required $1.47 per 8 oz. retail price (ERS, 2013) – Pricing data is US average, specialty retail price may be much higher – Target market may be willing to pay more (health benefits, families with children, seniors, etc.) – What packaging, labeling, etc. may differentiate the product?

U-Pick Pricing Example Strawberry u-pick operation – 10,000 pounds per acre – $23,600 in revenue per acre $2.36 per pound retail price (ERS, US Average 2013) – $18.88 in revenue per person Average consumption is 8 pounds/year (ERS, 2014) Need to know the cost of production (including visitor services, permits, etc.)

U-Pick Pricing Example Considerations – Visitors may purchase much more than 8 pounds (processing, events, etc.) – Visitors may be willing to pay more or less than retail depending on… Experience – Family outings, may pay much more per pound for the farm experience Amount purchased – Bulk purchases for canning, freezing, etc., may pay less per pound Specialty item – For organic, and other specialty labels or designations may pay more per pound – $3.48 organic wholesale price per pound (ERS, San Fran 2013)

Pricing Resources Fresh and processed fruits and vegetables – and-vegetable-prices.aspx and-vegetable-prices.aspx Meats and poultry – price-spreads.aspx price-spreads.aspx Organic foods – prices.aspx prices.aspx Drinks and meals away from home – products/quarterly-food-away-from-home- prices.aspx products/quarterly-food-away-from-home- prices.aspx

Activity Worksheet 5.1: Potential Volume – Identify 1-2 target consumer groups – Where are they coming from? – Where are they headed? – How many do you estimate? – What quantities will they use/buy?

Thank you!